John Redwood Speaks on Budget Resolutions and Economic Situation debate

Please find below the text of John Redwood’s speech to the House of Commons from yesterday’s Budget Resolutions and Economic Stuation debate.

Mr. John Redwood (Wokingham) (Con): It has been interesting to be present at this debate, which is a bit like “Groundhog Day”. We had a themed debate rather like it as part of the European scrutiny process, and we will doubtless have a similar debate on Second Reading of the forthcoming Climate Change Bill.

We have seen the three Front-Bench spokesmen all tiptoeing towards the proposition that people should have to pay more for their energy but understanding, as politicians, that that is an extremely difficult thing to sell to them. We have three variants. The Government’s view is that this is probably the least bad excuse to use for raising more money, because they are desperately short of money; Conservative Front Benchers are saying that green taxes should be entirely balanced by other tax cuts so that people would be able to afford them, assuming that the distribution was fair; and the Liberal Democrats are in their usual muddle saying that there is a bit of this and a bit of that, but undoubtedly wanting to tax people more—rather more, I suspect, than the Government.

The tragedy of all this is that those who want to redistribute income cannot guarantee to do it effectively by this particular route. People on low incomes need access to energy and transport just as people on high incomes do, so the Government are driven back on proposals in the Budget to have a one-year increase in the amount of fuel payment assistance for pensioners. That goes a little way towards helping, and other methods will need to be developed if the political classes decide to carry on with accelerating the progress of the market and having ever-dearer energy. We have already seen in recent months a huge energy price signal sent by the big increase in oil prices and the attendant changes in gas prices, coal prices and so forth. If the political classes want to accelerate that process even further by separate carbon levies, carbon trading with artificial prices and other regulatory and tax costs, more work will have to be done on how to do something about the fairness of distribution of those tax rises and cost rises, and there will have to be ways of offsetting those so that people on low incomes do not feel that they are taking a disproportionate share of the burden and are the ones who are deprived of transport and home heating.

Kelvin Hopkins: The right hon. Gentleman seems to be putting forward a rather socialist message, which I welcome, in suggesting that tax should be progressive rather than regressive. What about taxing the rich a lot more and insulating poor people’s houses?

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Mr. Redwood:
I think that the hon. Gentleman knows me well enough to be aware that that is not my view of the world. More people can be got out of poverty and into work by moving generally towards lower taxes than towards higher taxes. However, I was making a specific point on the content so far of today’s Budget debate and reminding all those involved in policy formation that one cannot simply carry on with the idea that extra taxes, extra levies and extra regulatory costs can be heaped on to energy without having consequences not only on the rich but on the poor and without needing to have some kind of alternative package. If we are not careful, we just end up with massive administrative churn costs because of the imposition of a lot of administrative costs in raising the levy, the charge and the tax, and then a lot more administrative costs in giving money back to people so that they can afford the levy, the charge and the tax, and we do not achieve what we are trying to achieve. I rather like green promotion in the form of lower taxes for better behaviour. It is good that we have already heard that that worked, as it did very quickly, when we did it for unleaded petrol, which showed that people prefer an incentive to tax increases.

It is important that people listening to our debates, as I hope that some still do, understand that we know that a very big financial crisis is under way in the world and that that crisis has moved on at breakneck speed during the course of the Budget debates. We heard a few brief remarks from the Prime Minister in his statement earlier, but we have not yet had the benefit of Treasury Ministers explaining in this House how they responded to the Bear Stearns catastrophe and the rescue that has been mounted so quickly and successfully in the United States of America, nor have we had from them proper comment on the actions being taken to co-ordinate putting liquidity into markets and seeing the market through the crisis.

In the Budget speech, the Chancellor rightly had a paragraph or so of reference to the world financial background, explaining that it was bleak, but he also claimed, with a hint of complacency, that the UK is uniquely best placed to deal with this crisis. We should try to ensure that the Chancellor and his colleagues have thought through the gravity of the world situation in which we find ourselves and the way in which, in some circumstances, the UK is not uniquely well placed but has its own home-grown problems, which we need to take very seriously. After all, it would be foolish to be complacent given that it was the United Kingdom that had the first run on a retail bank—and, I am pleased to say, the only run; let us hope that it turns out to remain so—whereby retail depositors were so worried that they were rapidly pulling out their deposits, which is what finally triggered the intervention and action over Northern Rock. Bear Stearns is a different kind of run by a different type of investor and depositor—equally lethal but not as telegenic and not affecting people on low incomes as the Northern Rock run visibly and clearly did.

We should ask why, over that long and difficult, and rather cold and wet summer, the British authorities were unable to take pre-emptive action of a kind that might have prevented the Northern Rock crisis developing as rapidly as it did. I am not jogging backwards—I was writing and saying this at the time.
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It was clear to the markets in London in August, if not July, that there was not enough money in circulation, and clear to those watching the markets that there was the potential for a financial disaster or a banking problem. I did not write down the names of the banks that were being mentioned at the time, but Northern Rock was the one that people most feared for, and it was widely rumoured in the markets. It would have been crass to mention it because the last thing that one wants to do is to play any small part in helping to undermine an important institution, crucial as Northern Rock has been to the success of the north-eastern economy and crucial as it is to all the small shareholders and depositors particularly concentrated in the Newcastle and wider north-eastern region.

The Bank of England was placed in an extremely difficult position in August and September. The reforms of 1997 had left it ill placed to understand the nature of such a banking crisis and to be able to respond positively to it. My first recommendation is that the Chancellor urgently look again at the regulatory and banking control framework that he inherited from the 1997 reforms and that he come to this House rapidly to introduce proposals for their improvement and updating.

A central bank is more than a regulator. A good central bank is more, even, than a hands-on referee in a free-flowing game. It is a player in the money markets that it has to supervise, and has to keep liquid, honest and successful. The problem for the Bank of England in August and September, when the money market participants could see that there were difficulties, was that, since 1997, it has lacked two important flows of information that most central banks regard as normal. First, a central bank needs to know everything that the Government are doing.

The Government are usually one of the biggest operators in the money market—particularly a heavily borrowing Government like the present one—and the timing and nature of debt that the Government issue is crucial to the functioning of the market. In 1997, the then Chancellor nationalised the function of running the Government’s debt by taking it out of the Bank of England and putting it into the Treasury. The modern Bank does not have the same minute-by-minute detailed sight of or responsibility for Government business in the market that it had prior to 1997.

The second big problem that the Bank of England has is that prior to 1997, it was the day-by-day banking supervisor of all commercial banks, particularly the main credit-creating clearing banks that run our system. The Bank could see all of that business, and knew about it day by day, hour by hour and minute by minute. It had a close relationship with those banks—the famous Governor’s eyebrows would rise wisely or angrily if anything went wrong. The Bank knew whether they were liquid enough, whether they had squared their positions early enough in the day and whether they were taking a sensible position in the markets, so the banking system worked well.

That responsibility was lifted from the Bank and given to the Financial Services Authority, and is now handled through a tripartite arrangement with the Chancellor and the Bank of England. When the crisis
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struck, it was always likely that it would be more difficult to control and resolve because the principal central bank player did not have all the regular information or history and knowledge of marketplace activity that a central bank should have. That is why I warned, in an economic policy report that I wrote for the Opposition, that we had a weak structure in Britain, and that when there was a financial difficulty—I did not forecast Northern Rock, but I had something like that in mind—things would go horribly wrong because the Bank no longer had those important powers.

The next curious matter is that just prior to the run on Northern Rock, the tripartite system clearly misread the situation very badly. Both the Chancellor of the Exchequer and the Governor of the Bank of England made fierce speeches in which they said that the banking system in Britain had made lots of mistakes by lending too much money to the wrong people, and that it had to meet the consequences of those mistakes—there would be no bail-outs. That would be a heroic thing to say at the best of times; in practice, no Government can allow a major bank to go bust in our global system because many poor and rich people would suffer badly, and there could be a systemic crash throughout the world. It was particularly odd, however, to make such statements when they must have known that they were on the verge of a difficult crisis over Northern Rock, with a possible run on the bank. They had to eat their words a matter of hours later when the run got out of control and the Chancellor said not only that he would guarantee all the deposits in Northern Rock—big though that task was—but the deposits of any bank found in a similar position, leading some to speculate who else in the markets he might have in mind. There was a worry that the run on Northern Rock would lead to a run on other institutions, which there is no need to name here. It is good that we are through that part of the crisis, that there is such a guarantee and that the tripartite system understands that it has to stand behind the banking system.

The guarantees, offers made and the nationalisation of Northern Rock now going ahead have not solved the problem, however. We are now in what some call the second leg of it. I do not think that the problem has legs; it is a continuing problem that will take some time to resolve, and we have just had another nasty chapter in the story—or drama, if you like—with the collapse of Bear Stearns on the other side of the Atlantic.

Mr. Bellingham: My right hon. Friend speaks with a great deal of expertise, but would he agree that one of the interesting features of the scenario is that the business models of Northern Rock and Bear Stearns had one item in common? The level of deposits in both were low compared with the amount of money lent out to customers and the wider market. But in the American case, the Federal Reserve intervened incredibly quickly and expeditiously, without any fuss at all, which stands in stark contrast to what happened here. In this country, the taxpayer, as my right hon. Friend rightly points out, is still heavily exposed.

Mr. Redwood: The speed of reaction shows an important contrast. I am pleased that the Bear Stearns rescue took place as quickly as it did because the scope
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for further collapses and bear raids on other American banks was considerable, and it is good that the American authorities responded strongly and positively because there would have been knock-on effects across the Atlantic on British institutions.

The American authorities are behaving rather differently from those in the UK. The American authorities believe the crisis to be so serious that they need to do two things: first, they need to keep driving interest rates down, and secondly, they need to continue making large sums of money available to keep the banking system liquid. In the UK, the authorities seem reluctant to move interest rates down because of the persistent but historic inflation we have to live through because of past monetary excess and difficulty, and they are making little money available—although they do occasionally make a co-ordinated effort to help to keep the banking system a little more liquid, as we saw in recent days. We need to ask why the matter is being dealt with in different ways, and which is right.

Critics of the Americans say that it is crass to lower interest rates because there is still an inflationary problem, and they go on to say that lowering interest rates will not make any difference because it is not that kind of crisis. Of course lowering interest rates makes a difference; the crisis is due to the fact that some people cannot afford to pay the interest on their debt and repay their loans. If the cost of the loans is lowered through a lowering of the general interest rate—a lot of the loans are linked to that rate—the process would be a bit easier. Some people will not go bust and some will still be able to afford their homes.

It is a bit odd that people are down on sub-prime lending. I would have thought that some in this House would have been overjoyed that people had come up with a way of letting the poor buy a home. Is that not rather a good thing to have done? It is a great pity that the process was overdone and that those involved did not back off sooner and realise that they needed controls that were a bit tighter, but we do not want to bring the whole edifice down and say that poor people can never borrow money to buy a home. Surely it is good news if the lower interest policy in the United States can see some people through this difficult period.

Martin Horwood: Is not one of the problems with the sub-prime business model that it factors in the cost of debt recovery? In other words, it is based on an assumption that many of the people they are targeting will not be able to afford the repayments that they are being offered. Does that not border on the immoral at times?

Mr. Redwood: All banking factors in the probability that some people will not be able to repay. There is not one single sub-prime business model, but lots of different business models for those making loans to people who are a bit hard up. Of course making loans to those who are hard up is more difficult than making loans to those who are rich, but there are not enough rich people, and there are not enough rich people who want to borrow, so it is necessary to lend quite a lot of money to those who are hard up. The art of banking is in deciding how much one can offer and under what conditions. If the authorities can see more of those poor people through by making sensible interest rate adjustments, I say, “Thank goodness for that”, rather
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than, “Serves them right—let’s keep the interest rates high, push more of them under and put them back into the trailer park.” That is not a particularly nice thing to do.

Will the policy be inflationary? I find it difficult to understand how people can say that the American authorities are irresponsible to cut interest rates because that will cause inflation, while at the same time they say that America is already in recession—a questionable proposition—and that it will have a hard landing in a very bad recession. If America is going into a bad recession, bankruptcy, unemployment and falling prices, not inflation will be the problem. The crash in house prices will extend to other goods and assets. I am therefore in favour of lowering interest rates in the conditions that we are considering to try to save something from the mess.

Should more money be made available to the banking system? The answer is simple: of course it should. Whatever people think of bankers—I know that several hon. Members are not best friends with bankers or have various political causes on which to fight them—one cannot live in a modern, sophisticated economy without them. We need people who assess risk, make loans and so on. If they get it catastrophically wrong and we push them all under, we simply make our lives worse, too. There must be moderation in the response, and understanding that we must see enough banks and lending through the crisis so that, if we handle it properly, normal life can be resumed and reasonable economic growth can continue. Money must therefore be made available to the banking system.

That brings me to my next policy recommendation to the Government. One reason why UK authorities cannot do much to make the system more liquid is that too many of the resources of the Bank of England and the Treasury have been expended on nationalising Northern Rock. The sooner the Northern Rock position is unwound, the better because our nation and our monetary authorities cannot afford to have so much tied up in a single, medium-sized—by international or even national standards—mortgage bank. Although the sum of money is small in relation to world financial markets, it is large in relation to the British taxpayer and the Government, and certainly in relation to the Bank of England.

When the Bank of England mounted its rescue of Northern Rock, the former was only 40 per cent. of the size of the latter. It was therefore impossible for the Bank of England to mount a full rescue by itself and that is why—I presume—the Treasury got involved and there had to be proper Treasury guarantees and promises. Taking on something the size of even Northern Rock—a relatively small bank by international standards—required the whole weight of the consolidated fund of the UK and the Government’s money-raising powers. The Government therefore need to accelerate the process of either running off the business or developing new business under whatever model the managers can devise so that we get the £25 billion back as quickly as possible. The Bank of England would thus have a better profile of assets and liabilities again, and more money with which to play in the markets.

In the meantime, perhaps the Government should consider the financing of the Bank of England money market operations because I do not believe that it is
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playing with enough money, and it needs to have a bigger cash reserve available to keep the banking system more liquid during the difficult times. It will not be easy. I am an optimist and I believe that we can get to the other side, but it will require a more intelligent approach by the British authorities than they employed in August and September, and more weaponry in the form of lower interest rates and cash availability in the UK, just as enormous firepower is required in the United States as it, in the eye of the storm, tries to make its way through it more quickly.

The general problem is over-indebtedness worldwide, especially in the American, British and similar economies. The good times were a period of easy credit, when the authorities on both sides of the Atlantic kept interest rates a bit lower than was sensible and either encouraged or turned a blind eye to the most massive build-up of debt under new types of debt obligation and debt structure, which we had not previously experienced. In a way, the regulators fuelled much of that. The Basel rules of capital adequacy told all sensible banks that wanted to grow quickly and increase their profits, “Do so off balance sheet.” The rules encouraged—in a way, forced—them to do that. Surprise, surprise, the banks went for massive off-balance-sheet financing.

Now, many in the Government and elsewhere have become critical and say that perhaps off balance sheet was overdone and not properly appraised and controlled. However, the Government are up to their neck in the off-balance-sheet operation because they are the biggest exponent by a mile of such financing in the UK. In the Red Book, the Government show roughly £500 billion of borrowing for the state in an economy of about £1,300 billion. The Government state that they are keeping their debt to around 40 per cent., which is the target that they set themselves.

When I last did the sums and considered the UK in the way in which a finance director would have to examine it to stay out of jail when reporting, rather than by using the Government’s method, I concluded that the British state’s true indebtedness is £1.3 trillion—£1,300 billion or 100 per cent. of GDP. I reached that conclusion because of the huge unfunded pension liabilities and the large pension deficits in the state sector, the private finance initiative and public-private partnership obligations, publicly owned companies, such as Network Rail, whose debt should be part of the state sector, and now, of course, the full consolidated sum for Northern Rock. Just as Northern Rock consolidated the whole of Granite, so the Government, having acquired Northern Rock, should consolidate the whole of it.

There is, therefore, a large debt on the state sector books, but much of it is suppressed from the general public gaze because of the accounting conventions that the Government deploy, which are so different from those that are required of the private trading sector. The Government need to start reducing their debt burden and demonstrating that they are serious about helping to unwind the debt crisis, taking a different attitude to PFI, PPP, off balance sheet and guarantees of trading companies, into which they entered so liberally in recent years. That would send a good signal and create a bit more financial capacity, which would
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help the state sector in all sorts of ways. It would help not least the money market, which would have a little more leeway if there are squalls ahead in the private banking sector, which need liquidity or financial instruments to be traded in open market operations.

The Budget was the most extraordinary non-event because it dealt with moving a few hundred millions around in a £1,300 billion economy. I am happy that the elderly will get a bit more help with their fuel bills. One would expect a Secretary of State or a Minister from the relevant Department to make such a statement. One would also expect it to be a good news item. However, Budgets are about influencing the general direction, shape and size of the British economy. If a Chancellor currently wishes to make a decisive impact, the Budget must move around £7 billion, £10 billion or £15 billion. Several billions must be involved if the Chancellor is to have any impact other than a nice warm glow and a few pence in the pockets of a target group that he may wish to woo on Budget day.

The Budget was pre-empted by the supplementary estimates that went through the House last autumn and, more recently, last Monday. From memory, the supplementaries added up to an astonishing £22,000 million of additional spending. Some of that may be good spending and a little of it may be policy change, but most is testament to the fact that the Government have lost control of their public spending. They tell us one thing on Budget day about what they will do and the balance between spending and revenue, then, towards the tail end of the year, in November and March, they set out colossal sums of money and say that, Department by Department, quango by quango, by big or little numbers, huge overruns have occurred. The figures go through automatically, without debate, yet they are far more significant—they will make an impact on the economy—than the measures mentioned in the Budget.

I therefore recommend to the Government that, to try to get the British economy through the extremely difficult period in world finance, we need proper expenditure controls, Department by Department. We also need the side of the Treasury that the Chief Secretary leads to have much more of a grip on and daily information flow about what is happening and what is going wrong in order to intercept the overspends earlier, emphasise that they are unacceptable when it is still possible to do something about them and redouble the efforts, which are stated to be part of the Government’s policy in the Budget, to root out the abundant waste, inefficiency and incompetence.

We are now at the point where over-borrowing and indebtedness in the public finances are so gross that we need a complete staff freeze at the administrative grades. That should not apply to teachers, nurses and doctors, of course; indeed, we need to continue recruiting as many as we can afford. The general civil service and the quangocracy, however, is now extremely bloated. We need a control on numbers and we need to start slimming them down by natural wastage. I do not want to fire people—that is expensive and unpleasant, and not a nice thing to have to do—but I want to start shrinking the numbers on the public payroll quickly.

We need pension reform for new people coming into the public sector at all levels, because the gap between public and private pension costs is extreme in favour of
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high-cost public sector provision. Above all, public sector pensions will be difficult to afford in the years ahead and are swelling the big deficit on any accurate and honest balance sheet, if we were ever to get one from the Government.

We also need proper control over the use of management consultants and outside advisers of all kinds, which has got completely out of control. We need proper controls over the use of property. It would be a good idea to spend to save on energy, which is topical, given the theme of this debate. We just need professional management, Department by Department, which can start to flush out the excess billions of waste, incompetence and overrun, which the supplementary estimates pick up year after year, but which get so little debate or reporting.

That is a series of positive proposals for a nation battling with a world financial crisis, elements of which are made in Britain, and where parts of the British predicament make responding that much more difficult. I hope that the Government will listen seriously on the need to reform their handling of money markets before there is another disaster or mess. We cannot afford another one, and it was a very expensive rescue that had to be mounted. I hope that the Government will start to tidy up Northern Rock lending as quickly as possible, because that is money that we could not afford to have outstanding, and there are easy and simple ways of getting quite a lot of that money back more quickly.

I hope that the Government will realise that every penny in those supplementary estimates will be borrowed, because nobody came to the House and said, “We’ve had £22 billion of supplementary estimates, so we need £22 billion of extra taxation.” We should at least be thankful for that, but there should not have been £22 billion of extra spending. We need to get to grips with that and start rolling back unnecessary spending, so that we can have the Government under some control again.

Above all, we need the Government to understand that although there is too much borrowing and some of it has to be squeezed, that means doing something at home, in the Government account, as well as just blaming private sector banks in America. It is partly the Government, by going along with the over-borrowing, the off-balance sheet routes and the clever financing, who have helped to fuel the very crisis that they now say we can ride out more successfully.

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  • About John Redwood


    John Redwood won a free place at Kent College, Canterbury, and graduated from Magdalen College Oxford. He is a Distinguished fellow of All Souls, Oxford. A businessman by background, he has set up an investment management business, was both executive and non executive chairman of a quoted industrial PLC, and chaired a manufacturing company with factories in Birmingham, Chicago, India and China. He is the MP for Wokingham, first elected in 1987.

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